Method and apparatus for price improvement, participation, and internalization

ABSTRACT

A method for stock option trading includes receiving an option order at a market, contemporaneously receiving a copy of the option order at an electronic drop (EDrop) system, which is separate and distinct from the market, obtaining a potential cross quantity and a potential cross price based on the option order at the EDrop system, and submitting, through the EDrop system, a contra-order, with respect to the option order, to the market for fulfillment, wherein the contra-order specifies at least one of an underlying security potential cross quantity, and the potential cross price.

This application is a continuation of pending application Ser. No.13/038,253, entitled “Method and Apparatus for Stock and Index OptionPrice Improvement, Participation, and Internalization,” filed Mar. 1,2011, now U.S. Pat. No. ______, which is in turn a continuation ofapplication Ser. No. 12/062,348, entitled “Method and Apparatus forStock and Index Option Price Improvement, Participation, andInternalization,” filed Apr. 3, 2008, now U.S. Pat. No. 7,912,779, whichis in turn a continuation of application Ser. No. 10/786,196, entitled“Method and Apparatus for Stock and Index Option Price Improvement,Participation, And Internalization,” filed Feb. 25, 2004, now U.S. Pat.No. 7,392,218, which is in turn a continuation of application Ser. No.09/621,769, entitled “Method and Apparatus for Stock and Index OptionPrice Improvement, Participation and Internalization,” filed on Jul. 21,2000, now U.S. Pat. No. 6,829,589, all of which are hereby expresslyincorporated by reference in their entireties, including thespecification, claims, drawings, and abstract.

BACKGROUND OF THE INVENTION

The present invention relates to securities trading. In particular, thepresent invention relates to a method for trading stock options thatprovides an intermediary with copies of option orders destined for amarket.

An option (either stock or index) provides a contractual agreement thatallows the holder to buy or sell a security or its underlying cashequivalent at a designated price for a specified period of time,unaffected by movements in the security market price during that period.Put and call options, purchased both for speculative and hedgingreasons, are typically made in anticipation of changes in underlyingprices. A put option provides the holder an option to sell, or put,shares to the other option party at a fixed put price even though themarket price for the security declines. On the other hand, a call,provides the holder an option to buy, or call for, shares at a fixedcall price notwithstanding a rise in the market price for the security.

In the past, order flow providers (OFPs) generated option orders to buyor sell put and call options. In particular, the OFP accepted a customerorder (e.g., a buy put order), encoded the order, and transmitted theorder directly to a market. The market (e.g., the Chicago Board ofOptions Exchange or CBOE), received the order and presented it totraders that determined whether to fill the order in part, in full, ornot at all (i.e., an out) in a process often referred to as matching.The result of the matching process is then communicated back to the OFPthat subsequently alerts the customer.

The order flow processing described above, however, only provides aneffective mechanism for the market itself to trade options. In otherwords, past order flow processing was a closed system. As a result,other individuals and organizations that could also meaningfullyparticipate in option trading and possibly improve the customer pricewere excluded from the opportunity to do so.

A need has long existed in the industry for a method for trading optionsthat addresses the problems noted above and others previouslyexperienced.

BRIEF SUMMARY OF THE INVENTION

A preferred embodiment of the present invention provides a method forstock and index option trading. The method includes the steps ofreceiving an option order, a copy of an option order, or option orderinformation sufficient to ascertain the type of order and an associatedcontract (collectively referred to below as an “option order copy”),from an order flow provider. The option order is contemporaneouslysubmitted to a market. The option order copy identifies, as examples,puts, calls, contract elements including a contract identifier, anunderlying security, strike price, expiry, and option quantity. Themethod then determines a potential cross quantity and potential crossprice based on the option order and submits to a market a contra-order(with respect to the originally received option order) specifying thecontract (including the underlying security and expiry), as well as apotential cross quantity, and a potential cross price.

The option orders may be any of buy calls, sell calls, buy puts, andsell puts, as examples. Thus, when the option order is a buy call, thecontra-order will be a sell call, when the option order is a sell call,the contra-order will be a buy call. Similarly, when the option order isa buy put, the contra-order will be a sell put, when the option order isa sell put, the contra-order will be a buy put.

The method may also, for example, translate the option order from anynumber of order flow provider formats into a common internal tradingsystem format. Similarly, the contra-order may be formatted for anypredetermined destination market, including the CBOE, PCOAST, AMEX,PHLX, or ISE.

In certain embodiments, the method may automatically determine thepotential cross quantity and potential cross price and submit thecontra-order without human intervention. In other embodiments, themethod may popup a display that shows the contract elements, option bidprice or option ask price, market bid and ask prices for the underlyingsecurity, risk management information, and the like, at a traderterminal, and monitor the trader terminal for a submit indicator (e.g.,a click on a Submit button). In addition, the method may filter optionorders before automatically submitting the contra-order, or beforepresenting option order related information on the trader terminal.

BRIEF DESCRIPTION OF SEVERAL VIEWS OF THE DRAWINGS

FIG. 1 illustrates an option trading network.

FIG. 2 shows an exemplary option pop-up window.

FIG. 3 illustrates a data flow diagram for an EDrop server.

FIG. 4 shows a method for option trading.

DETAILED DESCRIPTION OF THE INVENTION

Turning now to FIG. 1, that figure presents a high level diagram of anoptions trading network 100. In FIG. 1, solid arrows representconventional order flow processing, while dotted arrows show extendedorder flow processing as described in more detail below. The network 100includes an order flow provider (OFP) 102, a market 104, and anelectronic drop (EDrop) system 106. At the OFP 102, a mainframe 108generates option orders that are transmitted over a network 110 to aserver 112 at the market. The particular market structure discussedbelow is that of the Chicago Board of Options Exchange (CBOE), but it isnoted that the present trading method may cooperate with any optionmarket.

The server 112 provides the option orders to an order routing system 114that forwards option orders to the BART 116. The BART (Booth AutomatedRouting Terminal) 116 is an exchange provided system that allows theOFP's staff to intercept an order for routing purposes. Orders routedthrough BART are eligible for packet restructuring. This allows for firmresponsible for the BART terminal to specify which information is passedonto the PARS Terminal. The PARS terminal is the destination of all BARTorders and is held by a broker in the trading pit. Once an order isrouted to PARS from BART the order will then be executed. A BARTterminal can handle limitless numbers of PARS stations giving the firmthe ability to route its orders very definitively. One or more floorbrokers 118 decide whether to fill, partially fill, or take no action onan option order. Resultant order acknowledgements are communicated backto the order routing system 114 over the link 120. The orderacknowledgements pass through the trade-match module 122 where initialclearing functions begin. A report of unmatched trades (i.e., outs) arecommunicated back to the OFP 102 via the link 124, while matched (i.e.,partial or complete fills) are communicated over link 126 to the OCC128. The OCC (Options Clearing Corporation) 128 processes thepre-matched trades for final clearing and settlement, and communicates areport of matched trades back to the OFP 102 through the link 130. Eachof the links 124-130 may represent a single connection through anetwork, or physically separate connections.

With the addition of the EDrop system 106, access to the market 104 isexpanded. The EDrop system 106 includes, for example, an applicationserver 132 (that stores executable applications), an e-mail server 134(responsible for sending and receiving e-mail), and a message queue (MQ)server 136. The e-mail server 134 is not a required part of the EDropprocess. In addition, the EDrop system 106 also includes a riskmanagement server 138 (that executes risk management software), a quoteserver 140 (that receives real time quotes from an external source), anda gateway 142 (that communicates with the market 104).

Also illustrated as part of the EDrop system 106 is a trader terminal144, a risk management system 146, and a option order message queue 148.An internal network, illustrated as an Ethernet network 150, connectsthe servers 132-142, trader terminal 144, and risk management system146. The external real time quote server 152 provides real time securityquotes and other statistics to the quote server 140.

The EDrop system 106 is connected to the OFP 102 through the WAN 154(although the EDrop system 106, OFP 102, and market 104 may all beconnected on a single network). As the OFP 102 generates an option orderfor the market 104, the OFP 102 contemporaneously generates a copy ofthe option order and transmits the copy to the EDrop system 106. TheEDrop system 106 thereby receives the option order at the same time, orwithin milliseconds after the market 104.

The option order copies are queued in the order message queue 148. Thequeue server 136 monitors the queue for new option orders, retrieves theoption orders, and presents the option orders on the trader terminal144. To this end, the queue server 136 (or software running on thetrader terminal 144) may identify in the option order option contractelements including underlying security, option quantity, expiry, strikeprice, and a contract identifier (e.g., an alphanumeric string).

As will be explained in more detail below, the trader operating thetrader terminal 144 may then determine a potential cross quantity and apotential cross price based on the option order. Subsequently, the EDropsystem 106 submits a contra-order, with respect to the option order,specifying contract elements including the contract identifier,underlying security, strike price, and expiry, as well as the potentialcross quantity and the potential cross price, to the market 104 forfulfillment.

Turning briefly to FIG. 2, that figure illustrates an embodiment of apop-up 200 displayed on the trader terminal 144. The pop-up 200presents, for the option order, the current market bid 202 and ask 204at the market 104 (as well as additional markets). The pop-up 200 alsoprovides trader ask 206, trader bid 208, and trader quantity entries210, a refresh button 212 (for updating the current bid and ask prices),a submit button 214, and a Cancel button. Pressing the submit buttonprovides a submit indicator to the EDrop system 106 that the traderdesires to send a contra-order to the market 104. The EDrop system 106prepares the contra-order, using the trader bid or ask price, and thetrader quantity as specified in the pop-up 200.

Additionally shown in the pop-up 200 are risk management entries 216Delta, Gamma, Vega, Theta, and Rho for WJNAS (the contract symbol forthis example), the trader current position, and the trader new position.The risk management entries represent trading parameters, boundaries orreferences and provide trading guidelines to the trader. The pop-upincludes other information as well, including indicators for AnImmediate or Cancel (i.e., an order is filled immediately at said priceand quantity at the moment upon presentation or cancelled), Day (i.e.,Day Orders are good at said quantity and price for the entirety of thetrading day in which it was entered into the market), MKT (i.e., aMarket Order to be traded at the quantity specified and the currentprice available at the market), NH (Price Not Held, i.e., an order atthe specified quantity but not held to the specified price, E-size (thequantity of the order received from the OFP 102), Average values forimplied volatilities, are captured in FIG. 2 for WJNAS at a moment intime at the values 31.836, 31.25, 32.81, 97.4375, and 97.5.

Returning to FIG. 1, the EDrop system 106 uses the link 156 through thegateway 142 to the EDrop order server 158 in the market 104 tocommunicate contra-orders, while the link 160 may be used to communicateresultant execution messages back to the EDrop system 106. The resultsof contra-order processing at the market 104 are also passed through thetradematch module 122 and OCC module 128 for reporting to the OFP 102.

It is also noted that the potential cross quantity, potential crossprice, and the decision to submit a contra-order may be automated. Inother words, in certain embodiments, the EDrop system 106 makescontra-order decisions automatically for every option order, or a subsetof option orders based on, for example, risk management criteria. Theremaining option orders may then be presented on the trader terminal144.

Take for example, an IBM option order specifying a purchase of 50 callsof IBM. The OFP 102 submits the IBM option order to the market 104, butalso contemporaneously submits an option order to the EDrop server 106.As the IBM option order makes its way to, and enters the market 104, theEDrop system 106 presents the IBM option order (and additionalinformation as noted above with respect to FIG. 2) on the traderterminal 144. A trader may then determine whether to meet the order inwhole or in part (or not at all).

For example, the trader may attempt to meet 15 of the 50 calls. TheEDrop system 106, in response, submits a contra-order, with respect tothe original order, to the market 104. In other words, the EDrop system106 sends an option order to sell 15 calls of IBM. At the market 104,the contra-order and the original order may cross, resulting in 15 ofthe 50 purchase calls of IBM filled by the EDrop system 106 through thesupporting infrastructure of the market 104.

Although FIG. 1 illustrates a single OFP 102, market 104, and EDropsystem 106, there may be multiple OFPs, markets, and EDrop systemsinterconnected. Preferably, an EDrop system converts option orders (andother messages) sent from each OFP into an internal standard format forprocessing. Outgoing messages (including contra-orders) are translatedinto a format compatible with their destination (e.g., the market 104).

Turning next to FIG. 3, that figure presents a data flow diagramrepresentative of the processing that occurs in the EDrop system 106.The OFP 302 sends option order copies (and possibly additional messages)to the EDrop system 304. The EDrop server 304 preferably converts theOFP 302 option order copy format into an internal trading system format.The same internal trading system format is preferably used for each OFPthat may be connected to the EDrop server 304. For example, the OFP 302may send an option order copy reciting the feedcode MSQVA. The feedcodeis then interpreted according to the standard specified by the OCC(Options Clearing Corporation) as an October 105 put for Microsoft(MSFT). The quantity may be obtained from a subsequent line in theoption order copy.

The fields provided in the internal trading system format areillustrated below in Table 1. The field values may be stored inindividual variables, or collected into one or more data structures.

TABLE 1 A. Message B. Trade C. Transaction D. Trade Status HeaderDestination Number E. Date of F. Time of Trade G. Confirmation H.Execution Trade time of Order Firm I. Execution J. Flags K. Symbol L.Exchange Broker Code M. Expiration N. Strike Price O. Price P. QuantityDate Q. Open R. Minimum S. Timed Order T. Good until Quantity Quantitycode U. Good until V. Stop limit W. Stopped price X. With pricediscretion fraction Y. Commission Z. Account AA. Sub account BB.Clearing rate firm CC. Routing DD. Specialist EE. Booth ID FF. User Datacode GG. User HH. Reserved comment space

The format of an option order varies from OFP to OFP. For example, theOFP 102 may use the fields shown below in Table 2.

TABLE 2  1. Buy/Sell  2. Call/Put  3. Quantity  4. Symbol  5. Month  6.Strike  7. Price Type  8. Execution Type  9. Firm Order 10. Price 11.Routing ID 12. Accounting Type ID 13. Sequence 14. Exchange 15. FillerNumber

An exemplary conversion of the fields shown in Table 2 to the fields ofthe internal trading system format shown in Table 1 is:

Field to Field 1 to J 1 to J 3 to P 4 to K 5 to M 6 to N

7 to J or S-X (depending on Price Type)

8 to J 9 to J 10 to V

14 to B and/or CC

All other inbound fields may be ignored and stored in a database. Notethat the internal trading system format includes many fields that arenot necessarily specified in a given OFP option order format. The fieldsare provided, however, so that the fields in more complex option ordersreceived from other OFPs may be maintained and manipulated in the EDropsystem 106.

The EDrop server 304 performs a first filtering operation 306 of themessages. The first filtering operation 306 allows for an immediate cutin the number of orders viewed by client processes. The filters include:

Size (the size of the order being traded),Order Type (Type of execution or pricing style to be applied to theorder at the floor.),Route (forwarded to client services based on Route specified, i.e., theexchange to which the order is to be traded).

Additional filters include: Underlying Symbol, Industry Sector, Betavalues and OFP disseminated criteria. An example implementation of afilter check on size is: If then contract specifies an order size lessthat the Auto-Ex (exchange automatically executed) size then filter theorder (i.e., do not present the order to the client process describedbelow).

Examples of execution types include Combination or Spread orders, GTC(Good till canceled), Day (Day orders), IOC (Immediate or cancel), orAON (All or none). Examples of pricing styles include Market (Marketprice), Limit (Limit to customer price), and NH (Not held to specifiedprice).

All messages received pass through the text dump process 308 and arestored in the unfiltered database 310. Messages that pass through thefirst filter process 306 are stored, using an SQL database process 312into a filtered database 314. Thus, the filtered database 314 preferablymaintains messages that are eligible orders, in the sense the ordershave passed an initial level of review and may result in a contra-orderas explained below.

Continuing with respect to FIG. 3, the messages that pass the firstfilter process 306 continue through a second filter process 316. Asexamples, the second filter process 316 may provide client levelfiltering to reduce the number of orders viewed by the end-user byremoving orders that meet a certain set of user-definable criteria.

The criteria may include, as examples:

Marketability (i.e., how valued is the order compared to the pricingavailable at the market),Delta Risk (i.e., the directional risk in the order),Position Risk (i.e., the manner in which the order being viewed willaffect the current position at a strike level, month level, and globalposition management level).

As an example, a filter check for marketability may be implemented bydetermining the current NBBO (National Best Bid/Offer) and sending onlyorders that are near or inside these parameters.

Additional filter criteria include: Theta, Vega, and Gamma filters, aswell as Volatility Filters, and Corporate Action filters. A customizableset of Price versus Edge filters are available for advanced filtering,in addition to Profit and Loss and Unit filters that refresh based oncurrent position changes. To that end, an API to which additionalfilters can be added is optionally provided. The API provides functioncalls to change the filters when the market conditions or positionstrategies merit those changes.

Messages (typically option orders) that pass through the second filterprocess 316 are presented to the EDrop Client 318. The EDrop client 318presents the option order copy information (and additional informationshown in FIG. 2, for example), on a trader terminal. Alternatively, theEDrop client 318 may make an automated decision of potential crossquantity and potential cross price, and automatically submit acontra-order to the market 104.

Contra-orders that are sent to the market 104 are preferably stored inan Order Table 322 in a database. After acknowledgement of a partial orfull fill, the EDrop client 318 may then store the associated fillinformation in the Fill Table 324 in the database. A further Trade Tableis also provided for stocks, bonds, and other security trades that donot arise from option order placement and acknowledgement.

With reference next to FIG. 4, that figure shows a flow diagram 400 of amethod for option trading implemented in software in the EDrop system106. The EDrop system receives 402 an option order copy from an OFP, andtranslating 404 the option order copy into an internal trading systemformat.

Next, the EDrop system 106 identifies 406 contract elements in theoption order copy. The contract elements may include, for example, acontract identifier, underlying security, strike price, option quantity,and expiry. As noted above, the EDrop system 106 may then filter 408 theoption order copy and display 410 decision-making information on atrader terminal. The decision making information includes, for example,the contract elements identified above, as well as underlying securitybid and ask prices (possible at many different markets), option bid orask price, risk management variables, and the like.

The trader then determines 412 a potential cross quantity and price,while the EDrop system 106 monitors 414 for a submit indicator (e.g.,the click of the Submit button 214). Subsequently, the EDrop system 106obtains the potential cross quantity and price from the trader terminal,and submits 416 a contra-order, with respect to the original optionorder, to the market. The contra-order includes, for example, thecontract elements including a contract identifier, underlying security,strike price, expiry date, potential cross quantity, and potential crossprice. Next, the EDrop system 418 receives order fulfillment messagesfrom the market 104 or OFP 102. The fulfillment messages may include,for example, full fills, partial fills, or outs, and are typicallystored in a database at the EDrop system 106 for tracking and reportingpurposes.

As noted above, the EDrop system 106 may instead automatically determine420 a potential cross quantity and potential cross price. To that end,the EDrop system may examine risk management criteria, such as those setforth above. As an example, if the presented order information from theOFP points to an increase in volatility exposure for the tradingposition, a reduced amount of the order may be acted upon. The EDropsystem 106 may then automatically determine a potential cross quantityof a reduced size and a potential cross price of that equal to the NBBO(i.e., the National Best Bid Offer).

While the invention has been described with reference to a preferredembodiment, it will be understood by those skilled in the art thatvarious changes may be made and equivalents may be substituted withoutdeparting from the scope of the invention. In addition, manymodifications may be made to adapt a particular step, structure, ormaterial to the teachings of the invention without departing from itsscope. Therefore, it is intended that the invention not be limited tothe particular embodiment disclosed, but that the invention will includeall embodiments falling within the scope of the appended claims.

1. A method for stock option trading comprising: receiving an optionorder at a server; contemporaneously receiving the option order at anelectronic drop (EDrop) system; and automatically generating a matchwith respect to the option order, wherein the match specifies at leastone of an underlying security potential cross quantity, and thepotential cross price.
 2. The method of claim 1, wherein thecontemporaneously receiving comprises receiving an option order selectedfrom the group of option orders consisting of buy calls, sell calls, buyputs, and sell puts.
 3. The method of claim 1, wherein the automaticallygenerating comprises automatically generating a sell call when theoption order is a buy call option order, and automatically generating abuy call when the option order is a sell call option order.
 4. Themethod of claim 1, wherein the automatically generating comprisesautomatically generating a sell put when the option order is a buy putoption order, and automatically generating a buy put when the optionorder is a sell put option order.
 5. The method of claim 1, furthercomprising displaying at least an underlying security, am optionquantity, at least one of an option bid price and option ask price, andan ask price at a trader terminal, and monitoring the trader terminalfor a submit indicator.
 6. The method of claim 5, wherein the displayingfurther comprises displaying underlying security bid and ask prices atthe market.
 7. The method of claim 5, wherein the displaying furthercomprises displaying risk management variables.
 8. The method of claim1, wherein the EDrop system is remotely located from the market.
 9. Amethod of trading in a securities trading network having a market, themethod comprising: receiving an order sent to a market at a firstserver; automatically obtaining a contra-order based on the order at thefirst server; and submitting a match of the order and contra-order to asecond server.
 10. The method of claim 9, wherein the first server isseparate and distinct from the market.
 11. The method of claim 9,wherein the order is one of a stock and index option order.
 12. Themethod of claim 9, wherein the receiving comprises receiving an orderselected from a group of option orders consisting of buy calls, sellcalls, buy puts, and sell puts.
 13. The method of claim 9, wherein thesubmitting comprises submitting a sell call when the order is a buy callorder, and submitting a buy call when the order is a sell call order.14. The method of claim 9, wherein the submitting comprises submitting asell put when the order is a buy put order, and submitting a buy putwhen the order is a sell put order.
 15. The method of claim 9, whereinthe market matches the order and contra-order before submitting theorder to the second server for fulfillment.
 16. The method of claim 15,wherein the second server is at an exchange.
 17. A trading networksystem, comprising: a market in communication with an electronic orderflow provider through a network, the market configured to receive theorder from the electronic order flow provider; and a server incommunication with the market, the server contemporaneously receivingthe order, and wherein the server obtains a contra-order based on theorder.
 18. The trading network system of claim 17, wherein the server isremote from the market.
 19. The trading network system of claim 17,wherein the server is separate and distinct from the market.
 20. Thetrading network system of claim 17, wherein the market matches the orderand contra-order.